Saturday, June 30, 2007

Synthetic greater fools, by Steve Randy Waldman: Yves Smith at
Naked Capitalism, riffing on
a post
by James Hamilton, ponders the question of why some CDO investors might have
bought securities that were "losers at the start". Hamilton suggests that
investors must not have understood what they were doing. As Yves puts it, "[H]ow
could investors be so dumb? The buyers were institutional investors, after all.
These guys are supposed to be pros." Yves suggests that underwriters, sometimes
believing their own hype, sometimes with adroit porcine cosmetology, did a great
job of selling iffy paper. Here's another explanation, on the buy-side.

Do you remember the "greater fool" theory of investing from the late-1990s?
For many high-flying internet stocks, the disconnect between stock prices and
"fundamental" valuation was so obvious that buyers knew they were purchasing
securities which, if held for the long-term, offered negative expected return.
But it was quite rational to buy them anyway, so long as it seemed likely that
someone else, a "greater fool", would buy them at an even higher price than the
one you paid. Most serious players understood there would be a reckoning
someday, but ...[t]hose willing to take big chances for a short time, and smart
enough not to try to play "double-or-nothing" indefinitely, did very, very well
for themselves.

At first blush, today's markets look nothing like the heady stockmarkets of
the 1990s. After all, many of the securities that seem overvalued now rarely
trade... Generally an underwriter sells an offering to institutional investors,
who may plan to hold the paper to maturity. If secondary markets are thin, if no
one is buying or selling, who could be the greater fool?

But, in fact, it is not "institutions" that buy this paper, but managers who
are paid for performance. And from a manager's perspective, all these securities
do trade, about once a year, when bonuses and performance fees are taken. During
bonus season, hypothetical valuations of illiquid securities become converted
into liquid nonrefundable cash, just like during an ordinary sale. Institutions
effectively purchase securities from themselves, at arbitrarily high prices, and
pay their managers a commission for the privilege. Financial innovation truly
has been a wonder these last years. Institutions have cut out the middlemen and
become their own greater fools, to the benefit of managers and the detriment of
other stakeholders. ...

Like a polluter earning immediate visible profits but exacting diffuse,
hard-to-measure costs, managers at hedge funds, endowments, and pension funds
are producing cash and "diffusing" risk whose costs will eventually be borne by
someone. Institutions may now be their own greater fools, but the rest of us,
apparent bystanders, may turn out to be the greatest fools of all.

Can experimental economics be used to improve policy design? This is an
interesting idea but one
question, and it's one the authors acknowledge, is if in general the experiments can be made complex enough to duplicate real-world conditions and capture all of the essential aspects of the market under examination:

Experimental economics
and policy design, by Steffen Huck and Jean-Robert Tyran, VoxEU: The general
public and many politicians tend to be sceptical that unregulated markets are
good for people’s well-being. Economists have known forever that laissez-faire
yields the first best only under fairly unrealistic assumptions. The theory of
industrial organisation describes when markets work, when they fail and how such
failures can be remedied. Unfortunately, these theories are often difficult to
relate to and to implement in practice. One reason is that theory is simple and
abstract. Reality, however, rarely cooperates with the simplifying assumptions.
Real-world complexity means that it is often difficult to measure exactly how
efficient a particular market is or to decide if the theory can be applied to a
particular case. It is often impossible to know whether the assumptions
underlying the theory are met in practice, or whether other un-modelled aspects
of the environment might be critical.

Experimental economics is one way to bridge the gap between simple theories
and “messy” reality. Over the last decade or so, economists have used economic
experiments to investigate when markets work and when they fail – at least in
the laboratory. The advantage of the experimental approach is that the markets
studied can be richer and more realistic than those that simple theories deal
with, yet they are also more structured and “controlled” than in the field.
Market experiments are richer because real people (rather than abstract
optimising agents) participate in these markets, and they are “controlled”
because the researcher knows the market conditions (e.g. incentives and
information available to market participants), and can manipulate these
conditions in a systematic manner. In addition, interaction outcomes like
prices, and the quantity and quality of traded goods, can be measured without
error.

For example, one market can be implemented in which firms compete for
customers, and outcomes can be compared with an otherwise identical market in
which firms do not compete. Experimental control enables the researcher to hold
all aspects other than competition constant. Because everything else is held
constant, the researcher can argue that differences in observed market outcomes,
like higher product quality, must be caused by competition between firms.
Experiments thus serve to fill the gap between abstract theory and complex
practice, and can provide guidance to both theory and policy practice. Of
course, it should be kept in mind that laboratory economies are still
comparatively simple realities. Experiments enable the researcher to draw truly
causal inferences, but the extent to which the implemented environment captures
the essential aspects of naturally occurring markets is always open to debate
and subject to scrutiny.

Undercover, under fire, by Ken Silverstein, Commentary, LA Times: Earlier
this year, I ... headed to downtown Washington for meetings with ... prominent
lobbyists. I had contacted their firms ... pretending to be the representative
of a London-based energy company with business interests in Turkmenistan. I told
them I wanted to hire the services of a firm to burnish that country's image.

I didn't mention that Turkmenistan is run by an ugly, neo-Stalinist regime.
They surely knew that, and besides, they didn't care. As I explained in ...
Harper's Magazine, the lobbyists I met at Cassidy & Associates and APCO were
more than eager to help out. In exchange for fees of up to $1.5 million a year,
they offered to send congressional delegations to Turkmenistan and write and
plant opinion pieces in newspapers under the names of academics and think-tank
experts they would recruit. They even offered to set up supposedly "independent"
media events in Washington that would promote Turkmenistan (the agenda and
speakers would actually be determined by the lobbyists).

All this, Cassidy and APCO promised, could be done quietly and unobtrusively,
because the law that regulates foreign lobbyists is so flimsy...

Now, in a fabulous bit of irony, ... the ... lobbyists have attacked
..., saying that it was unethical of me to misrepresent myself when I
went to speak to them. That kind of reaction is to be expected from the
lobbyists exposed in my article. But what I found more disappointing is
that their concerns were then mirrored by Washington Post media
columnist Howard Kurtz...

I can't say I was utterly surprised... Some major media organizations allow,
in principle, undercover journalism — assuming the story ... is deemed vital to
the public interest and could not have been obtained through more conventional
means — but very few practice it anymore. And that's unfortunate, because
there's a long tradition of sting operations in American journalism, dating back
at least to the 1880s, when Nellie Bly pretended to be insane in order to reveal
the atrocious treatment of inmates at the Women's Lunatic Asylum on Blackwell's
Island in New York City.

Tom Bozzo of Marginal Utility has doubts about some of the arguments
in the recent Supreme Court decision on
resale price maintenance agreements:

Leegin vs. PSKS: Vertical Price Fixing is Good for Some, by Tom Bozzo:
Yesterday, the Supreme Court's conservative majority
decided that arrangements to fix minimum retail prices ("resale price
maintenance," or RPM) between manufacturers and their retailers are not "per se"
anticompetitive and must instead be judged by the "rule of reason" on the merits
or demerits of particular RPM deals.

As an equity holder in an economic consulting firm, my first reaction was, "Woohoo!
The economic consultant's full employment act of 2007!" The second reaction,
after seeing Justice Kennedy refer to economic literature (Greg
Mankiw, via
PGL at Angry Bear, has the story as told in his principles textbook) on
potential beneficial effects of RPM arrangements was, "Oh, really?"
...

The standard story (again via Mankiw) suggests that RPM agreements may be
valuable in that they ensure retailers enjoy sufficient markups to pay for what
the manufacturer considers to be valuable ancillary services — retail shop
ambiance, demonstrations of complex products, etc. In the absence of such
arrangements, it's claimed, there's a free-rider problem as cut-price retailers
direct their customers to go to full-service stores for the free services and
then to come back to buy the product on the cheap. In the end, the full-service
retailers can't provide the services (or underprovides them) and everyone's
worse-off.

One thing about this type of arrangement is that it appears, on the face, to be
allocatively inefficient. That is, in static resource allocation problems, the
"market" puts resources to their best possible uses when prices and marginal
costs are equal. RPM agreements increase the gap between prices and marginal
cost of the affected retail products in order to subsidize the provision of
ancillary services at zero price. Whether and how much consumers benefit depends
on how they value the ancillary services; it seems uncontroversial that there
are, indeed, some people who don't need the hand-holding and/or don't care about
having a "free" skinny chai latte while they shop.

The part of the theoretical story that I buy less is that the subsidy is
necessary to solve the free-rider problem. An alternative is not that the
provision of the ancillary services collapses, but rather than full-service
retailers explicitly charge for them (or at least those with nontrivial costs).
This happens quite a bit in some markets. For example, interior decorators can
(and do) "unbundle" their design services by charging for design
consultation; they can (and will) rebate the design fees for customers who
subsequently purchase stuff through the designers. ...

PGL also points to a very interesting Wall Street Journal
Econoblog face-off on the subject. There, Larry White raises some rhetorical
questions that don't obviously have the answer he perhaps implies:

Friday, June 29, 2007

Why has the male-female wage gap narrowed, and why has
the narrowing of the gap slowed in recent years? Mark Doms
and Ethan Lewis discuss three possible explanations in the Economic Letter from
the San Francisco Fed:

The Narrowing of the Male-Female Wage Gap, by Mark Doms and Ethan Lewis, FRBSF
Economic Letter: According to several measures, the difference in wages
between men and women, the so-called "male-female wage gap" (MFWG), has shrunk
substantially--by about half--over the past several decades. This phenomenon has
been the subject of much research, speculation, and contention. For example,
some seek to explain why the gap narrowed so dramatically in the 1980s only to
narrow much more slowly in subsequent years. Others have considered the role of
new technology, which may have helped level the playing field between the sexes;
this view recalls the rise of office work at the turn of the 20th century, which
is also thought to have benefited women (Goldin 1990).

In this Letter, we focus on an important portion of the research in this
area, particularly as it pertains to the very sharp decline in the MFWG during
the 1980s. We summarize three of the more well-known possible explanations:
declining discrimination against women, rising skills and workforce attachment
of women, and changing selection. While each has strong merit in its own right,
none has come to be the dominant explanation. We speculate that it may be
fruitful, though challenging, to consider whether these three explanations
worked together, occurring simultaneously and reinforcing one another, to result
in the sharp narrowing of the MFWG in the 1980s.

Measuring the male-female wage gap

There are several ways to compare the wages of males and females, and no
single measure is perfect or preferable in every instance. The method most often
used in academic studies is to examine hourly wages for only full-time workers
using data sets such as the Current Population Survey (CPS) or Decennial Census.
These studies typically measure the difference in wages between the sexes after
controlling for differences in years of education and age. This approach ensures
that, for example, the wage of a 50-year-old female with a post-college degree
is not directly compared to that of an 18-year-old male who dropped out of high
school.

Figure
1 presents estimates of the evolution of the MFWG from 1979 to 2005 using CPS
data and controlling for age and years of education. It shows that the average
hourly wages of men who worked full time in 1979 were 37% higher than the wages
of their female counterparts. These estimates, like those of others, show that
the MFWG fell at a rapid rate through the 1980s and then decelerated in the
1990s and 2000s. Viewed in a historical context, as provided in Goldin (1990),
the rapid narrowing of the MFWG in the 1980s is quite unusual.

There is news today that "Core US inflation falls below 2%." Here is core inflation as calculated by the Dallas Fed since they started
keeping track of this statistic:

Whatever we hear about target inflation rates and target ranges,
practically in recent years there have been two inflation regimes for the core
measure, the 4% regime from about 1983 to 1990, a transition period from 1991
through 1993, then a 2% regime ever since. The question is whether the Fed will be
satisfied to stabilize inflation around 2% as it has recently, or whether it
intends to stabilize at a new, lower target establishing a third regime.

Fed Statement: Agnostic on Inflation Target, by Greg Ip: With core inflation
at 2% in April and perhaps about to go lower, Thursday’s policy statement by the
Fed dropped its reference to inflation as “somewhat elevated.” Some analysts saw
this as acknowledgement of an inflation target somewhere around 2%.

More likely, the Fed simply punted on the question.

When core inflation was at 2.4%, as it was as recently as February, it was
relatively easy for members of the Federal Open Market Committee to agree
inflation was “elevated.” No member apparently thinks a number that high
represents price stability.

At 2%, the question gets stickier. Some Fed officials say their comfort zone
is 1% to 2%, and inflation above the 1.5% midpoint of that range leaves them
unsatisfied. But some others, who have not publicized their views, don’t share
that. Extensive staff work, plus the experience of foreign central banks, have
suggested 2%, or something slightly lower, might be better. That number would
makes deflation less likely and avoid the potential costs of forcing the public
to adjust to a lower inflation rate.

As is well known, the FOMC is deep into a lengthy internal discussion of
communication issues, including the question of an inflation target. Until
that’s settled (if it ever is – progress has been slow), the FOMC, in its
official pronouncements, is likely to remain agnostic on the appropriate
inflation rate. Dropping the reference to “elevated” without replacing it with
anything may have been necessary to satisfy those who don’t buy into the 1% to
2% comfort zone without arousing objections from those who do.

On the communication issue, I don't see any reason why the Fed cannot (and should not) tell us
whether they intend to stay at 2%, as in the recent past, or whether they intend
to take inflation lower unless, as suggested, they don't know themselves due to internal
dissent. In any case, they should settle this and tell us how they intend to proceed.

Paul Krugman wonders why anyone would think it is O.K. for Rupert Murdoch to gain control of the Wall Street Journal:

The
Murdoch Factor, by Paul Krugman, Commentary, NY Times: In October 2003, the
nonpartisan Program on International Policy Attitudes published a study titled
“Misperceptions, the media and the Iraq war.” It found that 60 percent of
Americans believed at least one of the following: clear evidence had been found
of links between Iraq and Al Qaeda; W.M.D. had been found in Iraq; world public
opinion favored the U.S. going to war with Iraq.

The prevalence of these misperceptions, however, depended crucially on where
people got their news. Only 23 percent of those who got their information mainly
from PBS or NPR believed any of these untrue things, but the number was 80
percent among those relying primarily on Fox News. In particular, two-thirds of
Fox devotees believed that the U.S. had “found clear evidence in Iraq that
Saddam Hussein was working closely with the Al Qaeda terrorist organization.”

Mr. Murdoch ... is an opportunist who exploits a rule-free media environment
— one created, in part, by conservative political power — by slanting news
coverage to favor whoever he thinks will serve his business interests.

In the United States, that strategy has mainly meant blatant bias in favor of
the Bush administration and the Republican Party — but last year Mr. Murdoch
covered his bases by hosting a fund-raiser for Hillary Clinton’s Senate
re-election campaign. ...

Now, Mr. Murdoch’s people rarely make flatly false claims. Instead, they
usually convey misinformation through innuendo. During the early months of the
Iraq occupation, for example, Fox gave breathless coverage to each report of
possible W.M.D.’s, with little or no coverage of the subsequent discovery that
it was a false alarm. No wonder, then, that many Fox viewers got the impression
that W.M.D.’s had been found.

When all else fails, Mr. Murdoch’s news organizations simply stop covering
inconvenient subjects. ...[T]he Project for Excellence in Journalism found that
in the first quarter of 2007 daytime programs on Fox News devoted only 6 percent
of their time to the Iraq war, compared with 18 percent at MSNBC and 20 percent
at CNN. ...

Defenders of Mr. Murdoch... say that we should judge him not by Fox News but
by his stewardship of the venerable Times of London, which he acquired in 1981.
Indeed, the political bias of The Times is much less blatant than that of Fox
News. But a number of former Times employees have said that there was pressure
to slant coverage...

In any case, do we want to see one of America’s two serious national
newspapers in the hands of a man who has done so much to mislead so many? ...

There doesn’t seem to be any legal obstacle to the News Corporation’s bid for
The Journal: F.C.C. rules on media ownership are mainly designed to prevent
monopoly in local markets, not to safeguard precious national informational
assets. Still, public pressure could help avert a Murdoch takeover. Maybe
Congress should hold hearings.

If Mr. Murdoch does acquire The Journal, it will be a dark day for America’s
news media — and American democracy. If there were any justice in the world, Mr.
Murdoch, who did more than anyone in the news business to mislead this country
into an unjustified, disastrous war, would be a discredited outcast. Instead,
he’s expanding his empire.

In the frenzied weeks from March to June 1933, Franklin D. Roosevelt sent 15
messages to Congress and steered 15 major laws to enactment: among them, central
planning for industry and for agriculture, new regulation for banking and for
the securities exchanges, the Tennessee Valley Authority, the Civilian
Conservation Corps and a national system of unemployment relief.

''At the end of February,'' Walter Lippmann wrote when the special session
adjourned, ''we were a con-geries of disorderly panicstricken mobs and factions.
In the hundred days from March to June we became again an organized nation
confident of our power to provide for our own security and to control our own
destiny.''

The Hundred Days were only the start of a process that ended by transforming
American society. Who can now imagine a day when America offered no Social
Security, no unemployment compensation, no food stamps, no Federal guarantee of
bank deposits, no Federal supervision of the stock market, no Federal protection
for collective bargaining, no Federal standards for wages and hours, no Federal
support for farm prices or rural electrification, no Federal refinancing for
farm and home mortgages, no Federal commitment to high employment or to equal
opportunity - in short, no Federal responsibility for Americans who found
themselves, through no fault of their own, in economic or social distress?

These social changes have won general approval. Even the Reagan
counterrevolution, for all its 19th-century laissez-faire and Social Darwinist
passions, shrinks from abolishing the framework of social protection -the
''safety nets'' - created by the New Deal.

But what of the narrowly economic results? How effective was the New Deal in
reducing unemployment, promoting economic growth and altering the distribution
of income? And does the experience of half a century ago offer any guidance to
the nation in its economic perplexities today?

The technique of the New Deal was improvisation and experiment. ''It is
common sense to take a method and try it,'' F.D.R. said in the 1932 campaign:
''If it fails, admit it frankly and try another. But above all, try something.''

Except for that part about admitting failure frankly, this continued the rule
for Roosevelt's 12 years in the White House. In the intellectual circumstances
of the time, there was really no alternative to experiment. The Hundred Days
found the country in a state of invincible ignorance. No one knew the causes of
the Depression. No one knew the cure. Business leaders and academic economists
alike were analytically baffled and impotent.

Take the Persian Gulf crisis. Do we really know enough about the Mideast to
act with confidence? The U.S. has not had serious historic experience in this
region. A few missionaries went there in the 19th century, a few oilmen in the
20th and that is about it. We have no strong tradition of Arabist studies in our
universities. Most of the time we don't know what we are doing in the Mideast.

Thursday, June 28, 2007

Talk of rebuilding is a positive way to send a negative message. It says that
things are not okay the way they are - they need to be rebuilt - but the message
is one of hope rather than negativity. I think that was one of the keys to
Bill Clinton's success. He didn't just tell us "It's the economy, stupid" and
things aren't so good, people knew that. What made the difference is that he
articulated a plan and a vision, efforts such as rebuilding infrastructure
(which were, unfortunately in my opinion, largely abandoned later) that said
things don't have to stay this way if you vote for me. As I hear the discussion
of the economy, of Iraq, and of other things developing among Democratic
presidential candidates, I wonder if there's a lesson here. Yes, we know things
are bad, but can you give us any reason for hope? What will you do to change
things?

Discussions within the Democratic party over the deficit are related.
Economically, how important is deficit reduction now? While there are looming
problems on the horizon, my view is: not very. By historical standards, the
burden is not large and if we are making good investments that will pay
dividends in the future, the benefits exceed the costs.

Politically, how important is deficit reduction right now? Again, I'd
say not very. I think selling a positive message about how to improve
infrastructure, health care - the usual list of worries - gains more votes than
deficit reduction. If there were great economic gains from deficit reduction, I
would want to try to let voters know why they should be more concerned. But as I
said, I don't think there are big gains from deficit reduction and we can address
more pressing needs by not insisting on giving up potentially valuable projects
just to show an improvement in the deficit numbers.

Suppose, for example, that the war
in Iraq were to end before the next president takes office (and how I wish this wasn't a supposition), or tax cuts are rolled
back, or other measures are taken to make additional revenue available. Is our
most pressing need to reduce the deficit? I'm not talking about increasing the
deficit substantially, just what to do if additional funds becomes available. I think there is a discussion we need to have about whether our tax burden is equitably distributed, what are spending priorities are, and the level and progressivity of taxes needed to meet those priorities, but for now I think the politics keep us near existing revenue and spending boundaries.

Here's Robert Reich who not only thinks that we should maintain the 2% of GDP
deficit we have now, he believes the deficit should be increased to 3% of GDP:

Fiscal balance is a false economy, by Robert Reich, Commentary, Financial Times:
A quiet but important debate is breaking out inside the Democratic party. It
will largely determine whether the Democrats, should they win ... in 2008 ...,
will have enough revenue to do the things that need to be done in the nation.
The debate is over the importance of reducing the budget deficit and the goal of
a balanced budget.

In many ways it is a continuation of a debate that began at the start of the
Clinton administration. The difference is that then the budget deficit hovered
at about 5 per cent of US gross domestic product and there was broad consensus
it had to be reduced. Now, the budget deficit represents only around 2 per cent
of GDP, close to its historical norm. Yet it has become an article of faith
among some Democrats that fiscal prudence is a necessary precondition for
economic health. Indeed, ... Democrats’ proposed federal budget for the next
fiscal year avows a commitment to reduce the budget deficit still further.

The Democrats’ presidential candidates are in a fiscal straitjacket. They are
promising to address America’s sluggish wage growth and widening inequality by
fixing the schools, providing affordable healthcare to all, repairing the
nation’s infrastructure and leading the US towards new energy technologies,
while also protecting Social Security..., being tough on national defence and
homeland security. But they do not want to raise taxes, apart from rolling back
President George W. Bush’s temporary tax cuts... How can they accomplish all
this while still guaranteeing fiscal austerity?

When Bill Clinton was elected he promised to reduce America’s two deficits –
the budget deficit and the growing deficit of public investment in schools,
healthcare, infrastructure and environment. But the budget deficit was much
larger than expected. Hence, he put the investment deficit on hold. It remained
on hold for the next...well, it has now been 14 years.

In the late 1990s, when the budget deficit turned into a fat budget surplus,
President Clinton again ignored his original investment agenda. ... [W]orried that
Republicans would try to turn the surplus into tax cuts, Mr Clinton used the
scare tactic of telling the nation to “save Social Security first”. By 2000, as
budget surpluses mounted, candidate Al Gore proposed they be reserved for baby
boomers’ Social Security. When the surpluses still overflowed, Mr Gore said they
should be used to cut national debt.

The investment agenda had disappeared. Thus did Mr Clinton and Mr Gore tee up
a $5,000bn 10-year surplus for Mr Bush to give away mostly to America’s very
wealthy without the nation ever considering it might be used to finance what Mr
Clinton and Mr Gore were elected to do in 1992.

Democrats had become the official party of fiscal austerity. Fast forward to
now. The nation’s investment deficit is now much larger than it was in 1992. ...

Mr Bush has put rich people and big corporations first. Yet as a percentage
of GDP the budget deficit is now far less than in the early 1990s. If we cut
corporate welfare, raised taxes on the richest Americans, and allowed the
deficit to move up to 3 per cent of GDP then there would be plenty of money to
invest in the nation’s future.

Yet congressional Democrats have learnt the wrong lesson from the 1990s. They
have concluded that cutting budget deficits and balancing budgets is a sure-fire
formula for widespread prosperity. ... Their “pay-go” rules make it impossible
for them to do much of anything without raising taxes, yet they have been
unwilling to commit themselves to raising taxes on the rich. ...

Mr Clinton had it right in 1992. Inadequate public investment in the nation’s
future will condemn us to slower growth and shrinking prosperity. It is already
happening.

No surprise, the Fed left the target rate at 5.25%. Though there is some hint the Fed sees improvement in core inflation, today's press release is very similar to the last statement and, in the Committee's view, the balance of risks remains tilted
toward inflation. Comparing today's press release to the release from the previous meeting:

Globalization's Stir-Fry, by Harold Meyerson, washingtonpost.com:
...Now let's consider the suddenly hot issue of government ownership of private
American companies. Nobody on the left has seriously proposed nationalizing
private concerns for the past 60 or so years. During the 1980s, we did debate
what was called "industrial policy" -- whether the government should invest in
certain strategic industries -- but the idea was defeated by free-marketeers who
argued that our government should not be in the position of "picking winners" in
the U.S. economy, and that it probably couldn't pick winners anyway.

But, improbably, industrial policy is back. Only, it's not our government
that is buying up our companies and picking the winners. It's China's, and will
surely soon be those of Russia and other oil-rich states. ...[F]oreign
governments control a cool $5.4 trillion in foreign currency reserves and have
begun to invest a chunk of that in American companies. ...

To be sure, the Committee on Foreign Investment in the United States has the
power to nix such purchases if they compromise national security. But what is
the proper response of laissez-faire advocates to this sudden wave of foreign
government investment in non-security-related companies? It's okay if the
Chinese government owns a slice of our economy but not okay if our own
government does? We trust every other government more than we trust our own?

I posed this question to William Niskanen, chairman of the libertarian Cato
Institute... Foreign government ownership, he argued, shouldn't pose a problem
unless that government obtains a controlling interest. When I then asked whether
it would be a problem for the U.S. government to buy into such a company, he
answered immediately, "I don't think I would want to be a shareholder in a
company in which the U.S. government owned a good bit of the shares," and then,
pausing, continued, "I haven't thought about this" -- "this" being the
distinction between U.S. ownership and, say, Chinese.

Niskanen is hardly alone. None of us have thought sufficiently about how the
belief in untrammeled capitalism could lead to foreign governments, whatever
their agendas, controlling more and more of the American economy.

Upset that Rupert Murdoch, who kowtows to China, will buy the Wall Street
Journal? What if China itself buys the Journal? Would the Journal's
hypercapitalist editorial board oppose that free-market transaction?
Globalization, as I said, scrambles everything.

To answer this question, let us look at the production process as a sequence
of steps... At each step, inputs like computer chips and a bare circuit board
are converted into outputs like an assembled circuit board. The difference
between the cost of the inputs and the value of the outputs is the “value added”
at that step, which can then be attributed to the country where that value was
added.

The profit margin on generic parts like nuts and bolts is very low, since
these items are produced in intensely competitive industries and can be
manufactured anywhere. Hence, they add little to the final value of the iPod.
More specialized parts, like the hard drives and controller chips, have much
higher value added.

According to the authors’ estimates, the $73 Toshiba hard drive in the iPod
contains about $54 in parts and labor. So the value that Toshiba added to the
hard drive was $19 plus its own direct labor costs. This $19 is attributed to
Japan since Toshiba is a Japanese company.

Continuing in this way, the researchers ... tried to calculate the value
added at different stages of the production process and then assigned that value
added to the country where the value was created. This isn’t ... easy ..., but
... it is quite clear that the largest share ... goes
to ... the United States, particularly for units sold here.

The researchers estimated that $163 of the iPod’s $299 retail value ... was
captured by American companies and workers, breaking it down to $75 for
distribution and retail costs, $80 to Apple, and $8 to various domestic
component makers. Japan contributed about $26 to the value added (mostly via the
Toshiba disk drive), while Korea contributed less than $1.

The unaccounted-for parts and labor costs involved in making the iPod came to
about $110. The authors hope to assign those labor costs to the appropriate
countries, but ... that’s not so easy to do.

This ... illustrates the futility of summarizing such a
complex manufacturing process by using conventional trade statistics. Even
though Chinese workers contribute only about 1 percent of the value of the iPod,
the export of a finished iPod to the United States directly contributes about
$150 to our bilateral trade deficit with the Chinese.

Ultimately, there is no simple answer to who makes the iPod or where it is
made. ... The real value of the iPod doesn’t lie in its parts or even in putting
those parts together. The bulk of the iPod’s value is in the conception and
design of the iPod. That is why Apple gets $80 for each of these video iPods it
sells, which is by far the largest piece of value added in the entire supply
chain.

Those clever folks at Apple figured out how to combine 451 mostly generic
parts into a valuable product. They may not make the iPod, but they created it.
In the end, that’s what really matters.

The perils of inflation
targeting, by Axel Leijonhufvud, VoxEU: To control the price level,
Patinkin demonstrated many years ago, you need control of one interest rate
and one nominal asset for which the private sector cannot produce a close
substitute. Although the theory did not say so, in practice it was obvious that
this nominal stock had better not be very small. Just the copper coinage would
not do, for instance. Thus Monetarism relied on 1) control of the
base, 2) the stability of the base-multiplier which was ensured by reserve
requirements on banks, and 3) the only very slowly changing habits of the public
with respect to the use of paper currency.

Monetary policy, in this context, was thought of as operating on the
determinants of the equilibrium price level to which the actual level
would adjust, albeit with “long and variable lags.”

All that is long gone, of course. Reserve requirements are no longer
enforced, the private sector is busy producing ever more substitutes for the use
of currency -- and the base is now demand-determined. We are now in a
Wicksellian world of pure
inside money in which no determinate equilibrium for the price level exists.
Monetary policy then becomes the art of using the federal funds rate to control
the rate of change of the price level. Ideally, the Central Bank should
hit Wicksell’s “natural
rate” on the nose so that the price level would stay constant. But it does
not know what that rate is. It has to behave adaptively, therefore, watching the
inflation rate and countering any movements in it by moving the interest rate in
the opposite direction.

This is a High Wire Act! The long and variable lags are presumably still with
us. The feedback, when it arrives, is not always unambiguous. What prices belong
in “core inflation” if the CPI does not provide the best signal?

It is perhaps a sign of how far sub-Saharan Africa still has to go that the
most vigorous ... debate about its economic future ... has been
between two American economists based in New York. On one side ...
is Jeffrey D. Sachs, ... at Columbia University and the author of “The End of
Poverty.” On the other is William Easterly of New York University, whose
ironically titled “White Man’s Burden” lampoons Sachs...

Sachs’s ... conviction [is] that Africa can be saved with $75 billion a year
in Western aid. ... In Easterly’s opinion, the present generation of white philanthropists is no
more likely than earlier ones to succeed in a self-appointed (and at times
unwittingly imperial) mission of enlightening the Dark Continent.

Now comes another white man, ready to shoulder the burden of saving Africa:
Paul Collier, the director of the Center for the Study of African Economies at
Oxford University. ... It was Collier who ...
pioneered a new and unsentimental approach to the study of civil wars,
demonstrating that most rebels in sub-Saharan Africa are not heroic freedom
fighters but self-interested brigands.

Buffett cited himself, the third-richest person in the world, as an example.
Last year, Buffett said, he was taxed at 17.7 percent on his taxable income of
more than $46 million. His receptionist was taxed at about 30 percent.

Buffett said that was despite the fact that he was not trying to avoid paying
higher taxes. "I don't have a tax shelter," he said. And he challenged Congress
and his audience to see what the people who "clean our offices" are taxed...

These are countries whose per-capita incomes are greater than the OECD average.
The point here is that there's no trade-off between high levels of national
income and high levels of social spending. [more here]

Chris Hayes says government bureaucrats do not deserve the reputation that they have:

In Praise of Red Tape,
by Christopher Hayes, The Nation: Is there any figure in American political
discourse more reviled than the bureaucrat? Say the word and a potent caricature
leaps to mind: the petty and shiftless paper pusher who wields his small amount
of power with malice and caprice. ...

It's slander with a long pedigree--Cicero called the bureaucrat "the most
despicable" of men, "petty, dull, almost witless...a holder of little authority
in which he delights, as a boy delights in possessing a vicious dog"--but in the
last forty years, conservatives have converted this casual contempt into an
ideological fixture. Since as far back as the Goldwater campaign, the American
right has generally found that "the government" is too abstract an entity for
most people to actively loathe. It's far more effective to demonize the people
who execute its daily functions. Bureaucrats are ... an oppressive class of
joyless knaves. Milton Friedman quipped that "hell hath no fury like a
bureaucrat scorned"...

But a funny thing has happened over the past six years. At a time when the
press failed to check a reactionary Administration, when the opposition party
all too often chose timidity, it was the lowly and anonymous bureaucrats ...
who, in their own quiet, behind-the-scenes way, took to the ramparts to defend
the integrity of the American system of government.

I grew up in a small town, a place where everyone knows everyone pretty much, where you go to school with the same group of people from kindergarten through
high school, a place where that embarrassing mistake you made in second grade
never completely goes away. There are no secrets, at least not for long.

Things are different in a small town because you are rarely anonymous. Interactions on the roads, in grocery stores - anywhere at all really - are never a
one-shot game, you always have to be aware that there will be a next time, aware
that your reputation informs and is informed by every interaction. When you
apply for a job, your whole history comes with you, there's no
need for anyone to Google anything but their own brain to know your life story. If you are a business owner, repeat business is everything and you have
no chance at all if the town loses trust in you.

This is not an earth-shattering observation or anything, but as I was reading this column by Thomas Friedman on the new realities of the
digital world, about how young people need to be aware that their lives are being recorded like never before, I was struck by how much it sounded just like that town:

The
World is Watching: ...The implications of all this are the subject of a new book by Dov Seidman,
founder and C.E.O. of LRN... His book is simply called “How.” Because Seidman’s
simple thesis is that in this transparent world “how” you live your life and
“how” you conduct your business matters more than ever, because so many people
can now see into what you do and tell so many other people about it...

For young people, ... this means understanding that your
reputation in life is going to get set in stone so much earlier. More and more
of what you say or do or write will end up as a digital fingerprint that never
gets erased. ... For this generation, much of
what they say, do or write will be preserved online forever. Before employers
even read their résumés, they’ll Google them.

“The persistence of memory in electronic form makes second chances harder to
come by,” writes Seidman. “...[L]ife has no chapters or closets; you can leave
nothing behind, and you have nowhere to hide your skeletons. Your past is your
present.” So the only way to get ahead in life will be by getting your “hows”
right. Ditto in business. Companies that get their hows wrong won’t be able to just
hire a P.R. firm to clean up the mess...

“We do not live in glass houses (houses have walls); we live on glass
microscope slides ... visible and exposed to all,” he writes. So whether you’re
selling cars or newspapers (or just buying one at the newsstand), get your hows
right — how you build trust, how you collaborate, how you lead and how you say
you’re sorry. More people than ever will know about it when you do — or don’t.

Let's be clear. Money is polluting American politics as never before. But the
central problem isn't the issue ads. They're small potatoes relative to the
mammoth sums donated directly the the candidates, mostly by big contributors.
...

The ... 2008 presidential election is already turning out to be the most
expensive in history. And although the campaigns trumpet how many small donors
they’ve rounded up, the leading candidates in both parties are relying mostly on
big donors...

What to do? This Supreme Court will continue to use the battling ram of the
first amendment to protect the rights of the rich and the corporations in order
to mute the voices of the rest of us. So the real question is how to avoid the
Supreme Court's wrath while at the same time putting real limits on the power of
money in elections. The best idea I've heard is from Bruce Ackerman of Yale Law
School. Essentially, he wants to require that all contributions be put in blind
trusts for each candidate, so candidates can use the money but cannot know who
contributed what. ...

This way, the fat cats can support whomever they want and their first
amendment free speech rights are protected. But no one gets a seat at the
winner's table because the winners won't know who they're beholden to.

Is it possible to retain anonymity, or would corporations be able to credibly
signal their donations anyway? Ackerman (and Ayres) have, of course,
thought of this:

Donors might try to circumvent the process by, for example, producing
cancelled checks to the blind trust. Furthermore, extremely wealthy donors might
write very large checks and tell a candidate to watch for a significant increase
in his/her campaign account on a given day. To handle the first problem, the
authors suggest a five-day window within which a person could ask for his/her
money back from the trust. Politicians would never know whether a person
claiming to have contributed – and even showing a cancelled check – would really
have done so. To handle the second loophole, the authors would employ a “secrecy
algorithm” that would parcel large contributions to candidates in much smaller
chunks and over a period of days or weeks. Thus, no one contribution could
produce a large jump in a candidate’s account.

In
this post from last night, Robert Barro sketches out a model of Microsoft's social value. In
response Brad DeLong left a
comment, and in this post Brad continues and expands upon his remarks [the pdf linked in the first sentence is at the end of this post for convenience]:

Bill Gates's Charitable Vistas - WSJ.com: In 2006, [Microsoft's] revenue was
$44 billion, with earnings of $13 billion. This money was generated by creating
something consumers value. Only Microsoft's competitors could believe that this
much market value, revenue and earnings would have been created by delivering
products that have little value to society. Suppose that a copy of a new version
of Windows sells for $50 (and is typically charged as part of the price of a
personal computer). Microsoft's revenue from Windows would then equal $50
multiplied by the number of copies consumers snap up. Microsoft's earnings are
the revenue less production and development expenses. But that's not the social
value. That comes from the increase in productivity created when businesses and
households use the software. The social benefit equals the value of the extra
product, less the total paid for the software. Almost by definition, the benefit
has to be positive. Otherwise, why would consumers willingly pay for Windows? A
conservative estimate, in a model where software serves as a new variety of
productive input, is that the social benefit of Microsoft's software is at least
the $44 billion Microsoft pulls in each year.... Mr. Gates is free to do what he
wishes with his $90 billion. But I think he is kidding himself if he believes
that the efforts of the Gates Foundation are likely to provide society anything
like the past and future accomplishments of Microsoft. And, frankly, I would
have preferred to get the $300 per person "Gates Grants."

Jamie Galbraith argues that U.S. style economic liberalization is not the
direction Europe should take in the future:

Equality
and full employment can co-exist, by Larry Elliott, Guardian: Nicolas
Sarkozy: an apology. "Last month we may have given the impression that Nicolas
Sarkozy would herald a new free-market dawn for France. ... We now realise that
such assertions were without foundation. Mr Sarkozy, by his insistence on
removing the words 'free and undistorted competition' from the EU constitution,
has proved that France will remain a bastion of restrictive practices. We
apologise for any confusion caused."

Sarko, it appears, has had second thoughts. Far from signing up to the
liberalisation agenda..., the new French president said the treaty should
protect workers, reject cut-throat competition and turn its back fully on
US-style free-market economics. ...

All of which had Tony Blair and Gordon Brown (not to mention the European
commission itself) fuming. The only salvation for Europe, they argue, is to
embrace fully open competition, deregulation and flexible labour markets. ...

Sarkozy has some heavyweight support for his views. Last week..., the
Organisation for Economic Cooperation and Development (OECD), said that
globalisation had become a "potentially important source of vulnerability for
workers", and that the past 25 years had not only seen labour's share of
national income decline but also the distribution of income become more unequal.
...

Does it have to be this way? Not according to the OECD. "It has been claimed
by some that only countries which emphasise market-oriented policies ... may
enjoy both successful employment performance and strong labour productivity
growth simultaneously. This claim is not supported by the evidence, however."

I'm wary that this represents the "off-shoring" of problems, but
Jeffrey Sachs seems excited about it:

The Promise of the Blue Revolution (Extended version), by Jeffrey D. Sachs,
SciAm.com: ...By 2050 the earth could be home to more than nine billion
people with an average output of $20,000 or more, putting vastly greater
pressures on the Earth’s ecosystems if technologies of production and
consumption remain largely unchanged. Many environmentalists take it for granted
that richer countries will have to cut their consumption sharply to stave off
ecological disaster.

There is another approach ..., technologies that raise living standards yet
reduce human impact on the environment. A crucial group of such technologies is
aquaculture, the farming of marine animals... The rapid development of
aquaculture in recent years has been likened to a “Blue Revolution” that matches
the Green Revolution of higher grain yields from the 1950s onward.

One thing many people don't realize is that there is often a lot more behind the
opinion pieces written by people like Paul Krugman, Greg Mankiw, Hal Varian,
Dani Rodrik, Tyler Cowen, George Borjas, Robert Barro, Martin Feldstein, and others than it appears on the surface. That's not true in every case, but it is generally true when reputable economists weigh in on an issue.

For example, I recently had questions about calculations by Robert Barro in this editorial in the WSJ on Microsoft's social value. In response, he sent me this model that, though he does not regard it as definitive, explains
the basis of his arguments.

In the model, production of goods requires intermediate products like software. The level of output, as explained below, depends upon the variety of these intermediate goods, i.e. how many different types are available. Thus, as we discover more "idea-type goods" such as Windows, we are able to produce more output. Therefore, in this model, the invention of Windows and other products adds to the variety of intermediate goods, the increased variety allows more goods to be produced, and the increased output adds social value by allowing higher consumption levels. Here's the analysis:

Sketch of a Model of Microsoft’s Social Value, by Robert Barro, June 2007 [pdf version]: Goods are produced by competitive firms using the freely accessible
production function:

where A>0, L is labor input, xj
is the quantity of intermediate input of type j, and N is the number of
varieties of intermediates that exist. The quantity L is in fixed aggregate
supply. Although L is called labor, it really represents all of the usual rival
inputs to production (unskilled labor, skilled labor, capital—all treated here
as in fixed aggregate supply). Software and other idea-type goods are modeled
as the intermediates. These goods are treated, for simplicity, as
non-durables. The parameter α (0<α<1) will be the income share for
intermediates. The parameter σ (0<σ<1) measures substitutability among types of
intermediates. The presence of the last term in Eq. (1) will imply that total
gross output, Y, is proportional to N, and this property will allow for
endogenous growth in dynamic models where N grows due to R&D activity. The
present analysis considers only one-time shifts in N.

Suppose that an
intermediate of type j is priced at Pj>0. Competitive,
profit-maximizing producers of final output equate the marginal product of xj
to Pj. This condition yields the demand function:

Hence, if N is large, the
elasticity of demand for xj is approximately constant and equal to
‑1/(1-σ), which exceeds one in magnitude. (Competitive producers of final goods
hire labor at a given wage rate, w. In equilibrium, w equals the marginal
product of labor, and each producer of final goods earns zero profit.)

Each type of
intermediate, xj, is produced at constant marginal (and average)
cost, c>0. Without loss of generality, assume c=1. Thus, physically, a unit of
xj is “produced” by taking a unit of final output and placing a
j-type label on it. This labeling is assumed to be the exclusive province of
intermediate firm j, which owns the rights to produce that intermediate. (This
exclusive holder may be the inventor or developer.) The perpetual profit flow
for intermediate firm j is:

Monday, June 25, 2007

Perhaps this is not true. Perhaps the ruling regime in Iran is
merely seeking to persuade everybody that it is seeking to build
nuclear weapons. A country's political leverage is maximized when it is
nearly able to acquire nuclear weapons but has not yet done so. Its
neighbors and the world's great powers then have powerful incentives to
persuade it not to do so. It can, theoretically at least, extract
significant concessions in return for abandoning its nuclear ambitions.
And because it does not yet have nuclear weapons, it is not yet an
imminent threat to the survival of its neighbors, and very far indeed
from being an imminent threat to the great powers.

Let us hope that the ruling regime in Iran is merely seeking to
persuade everybody that it is seeking to build nuclear weapons in order
to extract concessions in return for abandoning nuclear ambitions that
it does not have. But let us not bet on that hope: it is a hope that is
likely to be in vain. It really does look as though the ruling regime
in Iran is attempting to acquire nuclear weapons.

Human-like altruism shown in chimpanzees, EurakAlert: Debates about altruism
are often based on the assumption that it is either unique to humans or else the
human version differs from that of other animals in important ways. Thus, only
humans are supposed to act on behalf of others, even toward genetically
unrelated individuals, without personal gain, at a cost to themselves. Studies
investigating such behaviors in nonhuman primates, especially our close relative
the chimpanzee, form an important contribution to this debate.

This week in PLoS Biology [open access], Felix Warneken and colleagues from the Max Planck
Institute for Evolutionary Anthropology present experimental evidence that
chimpanzees act altruistically toward genetically unrelated conspecifics. In
addition, in two comparative experiments, they found that both chimpanzees and
human infants helped altruistically regardless of any expectation of reward,
even when some effort was required, and even when the recipient was an
unfamiliar individual—all features previously thought to be unique to humans.
The evolutionary roots of human altruism may thus go deeper than previously
thought, reaching as far back as the last common ancestor of humans and
chimpanzees. In a related article, Frans de Waal discusses the issues brought
out by this discovery.

Are we "alert and knowledgeable" enough "so that security and liberty may
prosper together"?:

In the councils of government, we must guard against the acquisition of
unwarranted influence, whether sought or unsought, by the military-industrial
complex. The potential for the disastrous rise of misplaced power exists and
will persist.

We must never let the weight of this combination endanger our liberties or
democratic processes. We should take nothing for granted. Only an alert and
knowledgeable citizenry can compel the proper meshing of the huge industrial and
military machinery of defense with our peaceful methods and goals, so that
security and liberty may prosper together. --
Dwight D. Eisenhower, Farewell Address, 1961

We now have the "espionage-industrial complex," and exactly how citizens stay
alert and knowledgeable about secret government programs is a mystery:

Larry Summers with general guidelines on how to share the gains from globalization and technological change:

Harness market forces to share prosperity, by Lawrence Summers, Commentary,
Financial Times (free): When I studied economics in graduate school a
generation ago we were taught that it was a “stylised fact” that the US income
distribution was very stable. We were shown that the fraction of the population
in poverty tracked almost perfectly ... median family income over
time and that productivity growth and average real wage growth moved together...
These observations led naturally to the conclusion that the main way of reducing
poverty or increasing the incomes of middle income families was raising the rate
of economic growth.

Today, we have another generation’s worth of data... This experience forces a
reassessment of the earlier economic orthodoxy.

It can no longer plausibly be
asserted that the income distribution is relatively static or that average wage
growth tracks productivity growth. Indeed, in a recent paper ..., my
collaborators and I concluded ... that, ...[i]f middle income families had
shared fully in the economy’s income growth over the past generation their
incomes would have risen twice as rapidly!...

What should be done? ...[T]he answers are not entirely clear but probably lie
between the extreme positions... In the face of the experience of the past
generation it is no longer credible ... to argue that ... addressing questions
of ... distribution is populist or divisive. Given what has not happened to the
pay cheques of average workers..., it is not plausible to suppose that policies
that focus only on aggregate economic growth are sufficient to meet current
challenges.

Equally, arguments that suggest the only way to raise the incomes of
middle-class families is ... to regulate business practices more heavily or to
restrict increases in international trade are very dangerous. As much justified
concern as we have about increased inequality, ... it
could be much worse if the economy had not been able to achieve the ... under 5
per cent unemployment and sub-3 per cent inflation ... for much
of the past decade. This surely would not have happened without the US economy
benefiting from greater global integration. As western Europe’s long experience
with unemployment ... illustrates, we would be taking great risks if, in the
name of benefiting workers, we ... made production in the US less
competitive in the global marketplace.

The right approach is activist but it embraces activism that goes with –
rather than against – the grain of the market system. This is not a new idea.
The enduring legacy of the New Deal is not the many measures taken to regulate
prices or increase public employment. It is the measures such as securities
regulation and Social Security that do not seek to oppose but channel market
forces and mitigate their consequences. ...

Jeffrey Frankel believes the Kyoto Protocol represents our best chance to
address global warming, but it's "severely incomplete." Though the Kyoto Protocol's quantitative targets are not "the
economist’s favourite choice, a global carbon tax, they built desirable market
mechanisms such as international trading into the agreement." Here are his views on
how to build a successor to the Protocol that will "build on what is good about
it and fix what is most lacking." This proposal, which is part of a larger
effort (see the note at the end), deals very specifically with many problems
such as how to overcome dynamic inconsistency (the inability to bind future
governments to today's agreements), how to encourage developing countries to
join the agreement, and how to incorporate future uncertainties into the policy
framework:

It is a sign of how resigned the world has become to an absence of
enlightened leadership from the United States that some were prepared to receive
positively President Bush’s new position on Global Climate Change at the recent
G8 meeting in Germany. The President conceded that it is a problem that is worth
addressing. It will take more than this, however, to begin genuine progress on
the problem.

Start from two premises: (1) the Kyoto Protocol constitutes the only
multilateral framework we have to address climate change; and (2) the Protocol
is severely incomplete, particularly with regard to coverage across countries
(no participation of US or developing countries) and across time (nothing yet
agreed after 2012). Unlike most American economists, I believe that – given the
combination of political, economic and scientific realities as they are – Kyoto
was a good foundation, a good first stepping stone on the most practical path,
if we are to address climate change seriously. Although the negotiations
demonstrated that quantitative targets are more acceptable politically than the
economist’s favourite choice, a global carbon tax, they built desirable market
mechanisms such as international trading into the agreement.

But the furor in China is everywhere. Ordinary people are deeply shocked and
disillusioned at the government's inaction and indifference to basic human
rights!!! I am so sad to see my own country come to this day, I cry every time I
think of the poor kids and their parents, who have nowhere to seek justice. This
is just the tip of the iceberg. Over the internet people are saying that such
horrific abduction of people is everywhere. It is not a labor dispute. It is a
reflection of a very sick society that would pursue wealth at all cost. I can't
believe this is my country!

I am going to China soon and I will have chance to see more of people's
reaction to it. The world can't stay silent on THIS! I'd like to hear your and
your reader's opinion on it. My own impression of the central government is that
they are not sincere in truly solving it. At least the governor of the ShanXi
province has to be fired! The PM has to apologize to all the victims.

When the Fed talks about monetary policy, it says it doesn't worry about
the effect of its policies on inflation, unemployment, etc. in other countries,
its job is to do what's best for the U.S. economy and for U.S. citizens. Worrying about economic conditions in other countries is not its job, the Fed says, and it worries about the effect of its policies on other countries only to the extent
there is a feedback that will affect U.S. economic conditions (e.g. through demand for
our exports).

I'm not sure this is correct.
Conceptually this also involves topics such as immigration and trade policy, it involves any policy that can affect people both within and outside
of our national borders.

What should monetary, immigration, and trade policy use as the objective
function for policy, that is, what should the goal of policy be? Should U.S. economic policy
be devoted solely to the welfare of U.S. citizens, or should it be broader than
that?

I think there is an argument that national policy ought to be defined over
and devoted solely to the entity called a nation, and that policy that comes out
of congress, or the policy that comes out of the Fed, ought to be devoted to
making the nation and its citizens as well off as possible. It's the job of
elected officials and the Fed to improve conditions within the U.S., and let policymakers in other countries worry about economic conditions within their borders.

But that's not the argument I would use. Suppose, for example, just as a
rough approximation, that the citizens of a country weight their own welfare at
.75 and weight the rest of the word's welfare at .25 in any decision. Thus,
for example, immigration policy would be evaluated both on the basis of its effect on
U.S. citizens (75%) and its ability to help people in other, perhaps poorer,
nations (25%).

In such a case, shouldn't U.S. monetary, fiscal, immigration, trade, and
other policies reflect the preferences of U.S. citizens and take account of the effect of
policy choices on the residents of other nations? It seems to me that policy
should reflect the preferences of U.S. citizens. If U.S. citizens care about
foreigners, then maximizing the welfare of U.S. citizens requires policymakers
to consider how policy affects other nations, e.g. to take account of how
immigration, trade, and monetary policies impact the poor in Mexico, China, India, and other
countries. But that's not how we conduct monetary policy for sure, and not how much of
the immigration and trade debate is formed.

So who should national policymakers represent? Should policymakers represent U.S.
citizens only, or is there an argument (as I think there is) that U.S. economic policy ought to be broader than that if,
on average, U.S. citizens have preferences that extend beyond our borders?

Gelf Magazine looks at research on how social norms affect economic behavior, e.g. how conventions about how to split a restaurant bill change what people order. Do people take advantage of their dinner companions when the bill is split evenly and order more expensive meals, or do social conventions prevent them from exploiting such arrangements?:

A study ... tested that question. ... The finding: How you're going to pay
directly affects what you order. Research subjects chose the cheapest grub when
they were paying individually. When splitting the bill evenly, they ordered
pricier items. When paying nothing at all, their consumption went up even
further.

Gelf caught up recently with Uri Gneezy, one of the three economists who
conducted this experiment. Gneezy is ... at the University of California, San
Diego. We talked about ... economics ... [and] the importance of social norms...

Gelf Magazine: Why did you do this study?

Uri Gneezy: ...It is a nice demonstration of negative externalities. ... In
this case, the fact that I consume more has some externality—it has some effect
on you based on the additional cost that you have to pay for it. ...

GM: Your research subjects didn't know each other. Why would it make a
difference if you were with friends...? Because you care
more about them?

UG: I don't think it's because you care more, but because you know you can
get away with it once, but next time ... he'll eat the lobster... You'll pay for
it later on. That's why I expect it to be different with people you know well.
...

GM: What are the social implications of the results?

UG: In economics there is a big discussion about negative externalities: ...
Traditional economic theory assumes people are selfish. Then there is a new line
in economics that ... many times people do care a lot about others. Some of the
lab findings ... claim we do think about others when we make decisions. That may
be true in the lab, but that is not what we are finding when we go out in the
field. ... Negative externalities are important... People are selfish ..., just
like the traditional economic theory predicts. ... I think we show that there is
more to the original economic theory than new experiments claim: that people are
in fact selfish and react strongly to economic incentives.

Unlike his predecessor, Alan Greenspan, Mr. Bernanke had spent almost all his
adult life as an academic economist at Princeton. Except for two years as a Fed
governor, and a year as a top academic adviser to President Bush, he had never
had to make economic forecasts or to set policy with real money on the line. And
even then, most of the real power was in Mr. Greenspan’s hands.

Mr. Bernanke also seemed detached. He thrived on econometric models. He was
skeptical about relying on individual intuition and discretion, both hallmarks
of Mr. Greenspan. And less than three months into the job, Mr. Bernanke looked
naïve when he set off a market frenzy by chatting informally with Maria
Bartiromo of CNBC and telling her that the markets had misread the Fed’s
intentions. ...

If anybody has had to learn on the job, it has been Fed watchers and
investors rather than Mr. Bernanke. ... [F]inancial markets now accept the Fed’s view of the
economy and are no longer betting against it. That is a significant change. In May 2006, bond investors were convinced that
inflation was not going to slow the way Mr. Bernanke thought. But since then,
measures of core inflation ... have been edging back down...

A discussion of why Doha failed that cites unilateral trade reform in the past rather than regionalism, and high rates of growth in key developing countries (the World Bank says China will only lose the equivalent three days growth from the failure of Doha) as the main factors behind the breakdown in negotiations:

The Doha Round came to an impasse last week when four leading trading powers
failed to agree terms to liberalise international commerce at their meeting in
Potsdam. It is now almost inconceivable that the negotiations can conclude
before the next US administration takes office in 2009. Officially the talks
aren't dead. India's trade minister said the Doha Round was in intensive care
last year; if that was the case then, now it appears to be in terminal decline.

A mismatch in negotiating objectives sunk the negotiations in Potsdam. India
and Brazil wanted Europe and the US to commit to greater reforms of their
agricultural sectors, while the latter wanted the emerging markets to create
more commercial opportunities for exporters by cutting their manufacturing
tariffs further. It appears that Europe and the US both signalled some
flexibility, but it wasn't enough for India and Brazil. The Brazilian trade
minister said it was "useless" to continue negotiating on the proposed terms.
Last weekend I
argued that the Doha Round talks were unravelling ; Potsdam confirmed that
the leading trading powers hardened their negotiating positions. Under these
circumstances, an impasse is not a matter of ‘if’, but ‘when’.

Now the negotiations go back to Geneva, but don't bet on this working out.
Realistically the only person left who can put a deal on the table is WTO
Director-General Pascal Lamy. He should be cautious. If his proposal were
rejected, WTO members would probably blame him. The blame for this Round's
debacle lies squarely on the shoulders of WTO member governments, Mr. Lamy and
the WTO secretariat should not be sacrificial lambs.

Smog in London predates Shakespeare by four centuries. Until the 12th
century, most Londoners burned wood for fuel. But as the city grew and the
forests shrank, wood became scarce and increasingly expensive. Large deposits of
"sea-coal" off the northeast coast provided a cheap alternative. Soon, Londoners
were burning the soft, bituminous coal to heat their homes and fuel their
factories. Sea-coal was plentiful, but it didn't burn efficiently. A lot of its
energy was spent making smoke, not heat. Coal smoke drifting through thousands
of London chimneys combined with clean natural fog to make smog. If the weather
conditions were right, it would last for days.

Early on, no one had the scientific tools to correlate smog with adverse
health effects, but complaints about the smoky air as an annoyance date back to
at least 1272, when King Edward I, on the urging of important noblemen and
clerics, banned the burning of sea-coal. Anyone caught burning or selling the
stuff was to be tortured or executed. The first offender caught was summarily
put to death. This deterred nobody. Of necessity, citizens continued to burn
sea-coal in violation of the law, which required the burning of wood few could
afford.

Following Edward, Richard III (1377-1399) and Henry V (1413-1422) also tried
to curb the use of sea-coal, as did a number of non-royal crusaders. In 1661,
John Evelyn, a noted diarist of the day, wrote his anticoal treatise
FUMIFUNGIUM: or the Inconvenience of the Aer and Smoake of London Dissipated,
in which he pleaded with the King and Parliament to do something about the
burning of coal in London. "And what is all this, but that Hellish and dismall
Cloud of SEACOALE?" he wrote, "so universally mixed with the otherwise wholesome
and excellent Aer, that her Inhabitants breathe nothing but an impure and thick
Mist accompanied with a fuliginous and filthy vapour..."

Laws and treatises failed to stop citizens from burning coal, however. Too
many people burned it and there were no real alternatives. Anthracite coal was
much cleaner but too expensive...

At the turn of the century, cries to reduce the smoke faced a tough opponent.
Coal was fueling the industrial revolution. To be against coal burning was to be
against progress. "Progress" won out.

Not until the 1950s, when a four-day fog in 1952 killed roughly 4,000
Londoners was any real reform passed...

It caught my eye that when the "important noblemen and clerics" demanded that
King Edward I do something about air pollution, regulations that did not
make alternative energy sources available to lower classes at affordable prices
failed even under the threat of torture or execution.

...Sir: In "News from the lab" ... it is flattering to read that Kagel and
Roth (Handbook of Experimental Economics) is "the indispensable reference" on
experimental economics. But it is distressing to read that because "...unlike
physics, economics yields no natural laws or universal constants" it follows
that "...with or without experiments, economics is not and never can be a proper
science." By this definition, astronomy, geology, biology, perhaps parts of
physics itself, and certainly psychology must not be proper sciences either.

Rather than quibbling about definitions, it may help to consider how
laboratory experiments complement other kinds of investigation in economics, as
they do in those other sciences. Let me give an example.

One strategy for looking at field data (as opposed to laboratory data) is to
search out "natural experiments," namely comparable sets of observations that
differ in only one critical factor. The benefit of using field data is that we
are directly studying markets and behavior we are interested in, but the
disadvantage is that in natural markets we can seldom find comparisons that
permit sharp tests of economic theory.

In a 1990 paper (in the informatively named journal, Science) I
studied such a natural experiment, involving the markets for new physicians in
different regions of the U.K. in the 1970's. The markets in Edinburgh and
Cardiff succeeded while those in Newcastle and Birmingham failed, in ways that
can be explained by how these markets were organized. But as will be apparent to
readers of the Economist, there are other differences than market
organization between Edinburgh and Cardiff on the one hand and Newcastle and
Birmingham on the other. So, how are we to know that the difference in market
organization, and not those other differences, accounts for the success and
failure of the markets?

I grabbed this for a class I teach, but thought I'd post it here
too. It's somewhat long, and hence it's very thorough. If you want to learn about the Phillips curve, this
is a good place to start:

Inflation and Unemployment: A Layperson’s Guide to the Phillips Curve, by
Jeffrey M. Lacker and John A. Weinberg, FRB Richmond, Annual Report: What do
you remember from the economics class you took in college? Even if you didn’t
take economics, what basic ideas do you think are important for understanding
the way markets work? In either case, one thing you might come up with is that
when the demand for a good rises—when more and more people want more and more of
that good—its price will tend to increase. This basic piece of economic logic
helps us understand the phenomena we observe in many specific markets—from the
tendency of gasoline prices to rise as the summer sets in and people hit the
road on their family vacations, to the tendency for last year’s styles to fall
in price as consumers turn to the new fashions.

This notion paints a picture of the price of a good moving together in the
same direction with its quantity—when people are buying more, its price is
rising. Of course supply matters, too, and thinking about variations in
supply—goods becoming more or less plentiful or more or less costly to
produce—complicates the picture. But in many cases such as the examples above,
we might expect movements up and down in demand to happen more frequently than
movements in supply. Certainly for goods produced by a stable industry in an
environment of little technological change, we would expect that many movements
in price and quantity are driven by movements in demand, which would cause price
and quantity to move up and down together. Common sense suggests that this logic
would carry over to how one thinks about not only the price of one good but also
the prices of all goods. Should an average measure of all prices in the
economy—the consumer price index, for example—be expected to move up when our
total measures of goods produced and consumed rise? And should faster growth in
these quantities—as measured, say, by gross domestic product—be accompanied by
faster increases in prices? That is, should inflation move up and down with real
economic growth?

Friday, June 22, 2007

Are Asian regional trade agreements "a threat to the multilateral global trading
system and to other regions’ economic prosperity?" Richard Pomfret, writing at VoxEU, says there are more important things to worry about:

Asian regionalism: threat
to the WTO-based trading system or paper tiger?, by Richard Pomfret, VoxEU: The GATT/WTO system is based on the principle of nondiscrimination, the
unconditional MFN principle enshrined in Article I of the GATT. Despite several
waves of regional trading arrangements (RTAs) led by Europe in the 1950s and
1960s and by Europe and North America in the1980s and early 1990s, the
multilateral trading system prospered and the establishment of the WTO in 1995
reflected this strength.

The number of RTAs has mushroomed since the early 1990s in apparent conflict
with the multilateralism of the WTO. Some observers saw regionalism as a major
new feature of the global economic landscape.

Many of the 1990s RTAs were,
however, a fall-out from the end of Communism as countries dissolved and
Comecon was
replaced by a web of new RTAs in Eastern Europe; the increased number of RTAs
was a symptom of regional disintegration, not integration. With the EU
enlargements, this episode began drawing to a close, although the
cumulative
chart of RTAs on the WTO website ... does not subtract the 60+ RTAs that
became void after the EU’s expansion in 2004.[1]

Since the turn of the century, attention has turned east as over 70 RTAs have
been signed by East Asian countries. This is striking because during earlier
post-1947 waves of RTAs, the only serious Asian agreement was
ASEAN and this had little
impact on trade. China, Japan, Korea, Mongolia and Taiwan stood out as
practically the only countries showing complete respect for the MFN principle.

Fish criticizes
Sam Harris
and
Richard Dawkins for their confidence that natural explanations will be found
for currently not-well-understood phenomena of human behavior and consciousness.
He invokes
Francis S. Collins to name a scientist who would

argue that physical processes cannot account for the universal presence of
moral impulses like altruism, “the truly selfless giving of oneself to others”
with no expectation of a reward. How can there be a naturalistic [i.e.,
evolutionary] explanation of that?

Fish, let alone Collins, shouldn't need an economist to answer, "easy." Behaviors that don't seem to maximize individual fitness but may improve the
population fitness aren't a problem for evolutionary explanations. (Elaboration
of this concept, I gather, is Dawkins's major contribution to evolutionary
theory.) ...

The Darwinian explanation is that the behavior makes the group better off
despite (maybe) having cost to some individuals, which frankly doesn't sound
facially absurd under, say, a Divine Selection Hypothesis where "good works"
facilitate more pleasant after-lives. (An economist might argue that it's not
necessarily true that altruism necessarily is "costly" to the individual; at a
minimum, I would argue specifically that it narrows the real scope of
source-of-moral-behavior conundrums.) More to the point, Dawkins makes no claims
that obviously can't be explained in terms of neuron interconnections and brain
chemistry...

Robert Waldmann follows with:

Aunts, Fish, Ants, by Robert Waldmann: ATBozzo links to me
here... Thanks for link. Fish is, well fish. The possible evolutionary explanation of
altruism is quite different from the selection of sickle trait. The generally
favored view is called kin selection". The argument is that if we help a random
person (more generally organism in our species which we meet) we do something
very different from helping a random organism in our species, since we are more
likely to meet our kin than our non relations.

I don't know the correct legal answer here, I'll have to let the Supreme
Court handle it, the issue is the extent of third-party liability in the Enron
case. It is interesting, though, to have the consumer advocate fighting for free
market principles while the Bush administration stands in the way:

Sue the banks, by Jamie Court, MarketPlace: President Bush has stated that
the job of recovering shareholders' money from banks involved in the Enron
scandal should be left to SEC attorneys. But ... Jamie Court contends the best
path to justice is through the private sector.

Tess Vigeland: As we mentioned earlier, the Supreme Court issued a ruling
today that makes it tougher for investors to go after companies accused of
fraud. Well next week, the Court may decide whether to hear another case
involving Enron shareholders. They're trying to sue the banks that helped the
energy company work its numbers magic.

Opponents of the suit, including President Bush, argue the federal government
should be solely responsible for going after the banks. Commentator Jamie Court
says the private market provides the best path to justice.

Jamie Court: ...President Bush said he would count on SEC attorneys to
recover Enron shareholders' dough. That's why the White House isn't asking the
Supreme Court to let victims of stock fraud at Enron, or any other company, sue
the bankers that hid the sham transactions.

Headline: "Bush To Nation, Government Does Better Job Than Private Enterprise
System." Hmmm.

Well, the SEC regulators who deal with this every day want the Supremes to
let Enron victims directly sue Enron bankers. Why? Government lawyers know the
most efficient way for swindled shareholders to get their money back is through
private litigation, not government lawsuits.

Diverse Findings on Families’ Income Risk, by Greg IP, WSJ Econ Blog:
Americans’ risk of sudden drops in income is getting more attention politically
and among scholars. (Read
the article here.) The findings to date have been diverse. Yale political
scientist Jacob Hacker, author of The Great Risk Shift,
attracted widespread attention with his assertion that household income
volatility has tripled since the 1970s, while a new study by
Douglas
Elmendorf of the Brookings Institution and
Karen Dynan
and Daniel Sichel of the Federal Reserve, using the same
Panel Study on
Income Dynamics (PSID) as Mr. Hacker, find a far smaller, 24% increase.

Below are some links to research and writings on this issue. Mr. Hacker['s]...
most recent data is on his home page,
here.
In January,
he testified to the House Ways and Means Committee,
calling for expanded health care insurance guarantees and “universal
insurance”...

Peter Gosselin, a reporter at the Los Angeles Times
currently on leave at the Urban Institute, with
Robert Moffitt
at Johns Hopkins University used the PSID to document an increase in family
income volatility, in particular for the poor. Mr. Gosselin
wrote a series of articles on the
subject.

The Congressional Budget Office earlier this year found that
for individual workers, wage volatility had not increased.
The study is especially authoritative because it used social security
records to document people’s income, which are probably more accurate than the
recollection of respondents to surveys such as the PSID. Mr. Hacker argued,
in this message to economics blogger Mark Thoma, that the
CBO findings did not undermine his own, because he looked at household income
which may not follow the same pattern as individual income. Mr. Hacker said he
is working on “major reanalysis” of income volatility data. He could not be
reached this week for comment.

One of the earliest studies to find higher income volatility was by Mr.
Moffitt at Johns Hopkins University and Peter Gottschalk at
Boston College. They have recently
updated their research.

Mr. Elmendorf, Ms. Dynan and Mr. Sichel
have also
done preliminary research that finds consumer spending has not become more
volatile along with income. They argue that financial innovation, such as the
ease of borrowing against the value of a home, has enabled families to better
“smooth” their spending patterns even as incomes become more volatile.

That was from the WSJ's Econ Blog, an informative new addition to the Online
Journal. It's background for this story on family income volatility:

Incomes
Suffer More Volatility, by Greg Ip, WSJ: Weighing in on an intensifying
debate on income insecurity, three economists ... have found that American families today are more likely to experience
big drops in their income than three decades ago. Their analysis, however, finds
far less volatility in family income than some recent studies.

George Borjas says recent says a recent CEA report left a misleading
impression about the benefits from immigration by using a non-standard assumption of who ought to count in the calculations when tallying up
gains and losses. When a broader definition of "we" is adopted, and when theoretical results about the long-run impact of immigration are imposed, a different interpretation can be placed on the results in the report:

A careful reading, however, indicates that the CEA doesn't quite say that--and
they are very careful about avoiding that particular terminology. Nevertheless,
I think it is the “impression” one gets from the media coverage. Look at the
headline at the MSNBC
website: Immigrants 'Benefit US by $30bn'

I found that impression odd when I first saw the
report, ...[so] I took out a pad of paper and worked out
the mathematical model.

As I suspected, the $80 billion number does not mean what most people would
probably take it to mean. Economic theory predicts that the long-run
gains from immigration to the pre-existing population must be zero—even
when there are complementarities between immigrants and natives and even if
those complementarities are incredibly strong. In the long run, capital adjusts
fully until firms wither away all the excess profits from the initial wage
depression. A short version of the mathematical proof is
here, and here are more detailed
handwritten_notes.

The CEA used the Ottaviano-Peri result that the complementarities helped natives
and calculated how much natives gained as a result. This is what they
say:

Multiplying the average percentage gains by
the total wages of US natives suggests that annual wage gains from immigration
are between $30 billion and $80 billion.

But they completely ignored the fact that the
same complementarities that supposedly help natives also hurt immigrants, and by
quite a bit. In other words, the CEA uses a strange definition of who “we” are:
including only native-born workers and ignoring the millions of immigrants
already here who are affected by yet more immigrants. This choice is not one
that is typically made in the academic studies the CEA borrows from...